Optimal Annuity Portfolio Under Inflation Risk
22 Pages Posted: 6 Sep 2014 Last revised: 29 Dec 2018
Date Written: September 5, 2014
The paper investigates the importance of inflation-linked annuities to individuals facing inflation risk. Given the investment opportunities in nominal, real, and variable annuities, as well as cash and stocks, we investigate the consumption and investment decisions under two different objective functions: 1) maximization of the expected CRRA utility function, and 2) minimization of squared deviations from an inflation-adjusted target. To find the optimal decisions we apply a multi-stage stochastic programming approach. Our findings indicate that independently of the considered objective function and risk aversion, real annuities are a crucial asset in every portfolio. In addition, without investing in real annuities, the retiree has to rebalance the portfolio more frequently, and still obtains the lower and more volatile real consumption.
Keywords: Inflation-linked annuity, Retirement planning, CRRA utility, Loss disutility, Multi-stage stochastic programming
JEL Classification: C44, D14, D91, G11, G23, J26
Suggested Citation: Suggested Citation